Inflation, debt and IMF — What economic challenges lie ahead for the new government

Whoever comes to power in the days after February 8 will find that their campaign trail promises will hit the hard wall of reality almost immediately.
Published January 29, 2024

As polling day on February 8 draws near, a lot of promises have made by political leaders. These include commitments to provide relief from sky-high inflation, job creation and access to affordable housing. There are also promises to develop infrastructure, ranging from new universities and hospitals to highways and metros. The wish-list is long, but as the saying goes, if wishes were horses, beggars would ride.

Whoever comes to power in the days after February 8 will find that their campaign trail promises will hit the hard wall of reality almost immediately. Rather than focus on delivering relief, the new prime minister and their cabinet, in particular the finance minister, will at best find themselves firefighting during the proverbial honeymoon period, or at worst trying to maintain a slim grip on power through the end of the year.

Starting with negotiations with the IMF to enter into a new multi-year agreement — the $3 billion standby arrangement ends in February — to the presentation of a budget in the early summer, the going will be tough, and it will surely test the regime’s institutional relationships in ways that many are not fully grappling at this point in time. The budget season will perhaps be the ultimate litmus test of what will likely be initially positioned as a new same page — all of course necessary to realise the dreams and ambitions of the nearly 250 million souls that call the Islamic republic their homeland.

The troubles ahead

A lot of ink — perhaps data is the right term in today’s world — has been used to highlight the types of structural reforms needed by Pakistan’s economy. So rather than hash out the old wish list, it may be important to draw attention to the three key headwinds an incoming government will face, all of which will test the post-election ruling dispensation’s resolve.

First up is Pakistan’s debt situation, which will continue to limit the space a new government has in terms of providing relief to the masses. Without an IMF programme, Pakistan’s external debt situation will worsen dramatically, meaning that there will be no alternative to imposing austerity measures and finding ways to collect new taxes.

The former will ensure that the patronage networks underpinning the country remain thirsty, while the latter will test a new dispensation’s resolve to hurt the status quo elements that are integral to the current structure of Pakistan’s political economy. Given the debt dynamics at play, the government will also have to potentially navigate a decision on debt restructuring. Getting things on track with the IMF and staying the course reduces the likelihood for debt restructuring, but ill-timed decisions or delays may force the government’s hand, opening the door to a restructuring process that will carry its own set of dire implications.

The second issue will be inflation, which has been ravaging the purchasing power of millions of households for almost five years now. While upwards adjustments to prices, particularly energy, usually lead to a short-term spike in inflation, the larger issue behind the inflationary spiral is the fiscal deficit.

IMF-imposed austerity may help contain the inflationary beast, but that comes at the expense of growth. The alternative — cutting the size of the government and widening the tax base — comes at the expense of the status quo. Choosing the former limits the ability of the government to generate growth and by extension creating jobs, while choosing the latter puts the government on a path towards confrontation with status quo elements that may foment even greater instability in an already fragile system.

The final issue will be foreign inflows, which are critical to maintaining baseline levels of economic stability in Pakistan. While much has been said about the tens of billions coming in from friendly countries, no major inflows have materialised so far. SIFC or no SIFC, a new government will have to find new ways to attract foreign currency inflows.

The government would hope that an IMF programme would, like in the past, unlock additional multilateral flows, and some optimists may even think that Pakistan can borrow additional dollars from international capital markets. These could then help strengthen the currency, generating a spurt of growth in an economy that relies on import-based economic growth. But such a spurt would be short-lived, given the broader debt dynamics at play in Pakistan.

The likely scenario

On the flip side, the more likely scenario is that these inflows would be limited in scale, primarily because unlocking additional flows require major reforms that would be resisted by the status quo, or some geopolitical event that unlocks new rents for extraction. As a result, the trade-off for the government will be: angering status quo backers to reorient the economy and realise new inflows, or maintaining the status quo and hope some new rents — geopolitical or otherwise — materialise.

By the fall of 2024, the honeymoon period of the government will definitely be over. After making even some of the difficult choices highlighted above, any dispensation, even one with the most overwhelming support of the population, would find its political capital exhausted. Which means that the best case scenario leads us towards a situation where the ruling party in Islamabad is facing major pressures in 2025.

If the current situation were a bit different, perhaps the author would have recommended that voters ask politicians seeking their votes some tough questions related to their promises. After all, talking about creating jobs and providing relief to the masses requires upending the rent-seeking, patronage-dominated status quo. But if a government decides to upend the status quo in the current environment, it may find itself upended within weeks, if not days.

Whatever the results look like after February 8, the fact is that the party entering power will have very limited legitimacy to begin with, given the turn of events in the last few months. In such a situation, no government would want to antagonise the public writ large or even the key status quo patrons that underpin the country’s political economy. All of which is to say that rather than a year of major structural reform, 2024 may prove to be a year where Pakistan’s political economy muddles along at best, or is tested in unimaginable ways at worst.

Header image created with AI